19 promised to replace a defective unit at no cost to the customer within one
year of purchase and company thinks some of unit will be returned and the company will estimate the payable, it would book a contingent liability of
this amount on its balance sheet. Another case of contingent liability is relating with the lawsuit expenses.
2.2.3. Conservatism Measurement
The measurement of conservatism can be done by using several techniques. The five existing measures of accounting conservatism are:
1. Basu’s 1997 asymmetric timeliness measure
Basu’s 1997 operationalization of accounting conservatism focuses on the implication that earnings will reflect bad news more quickly
than good news. While the timeliness of accounting recognition of economic events has been well known, Basu was the first to link
asymmetric timeliness with accounting conservatism. According to Basu’s measure, the greater the asymmetric timeliness, the greater is
the degree of conservatism in a firm. Empirically, the following cross sectional regression is used to assess the degree of conservatism:
EPS
i,t
P
i,t
= =
+ =
1
DR
i,t
+ R
i,t
+
1
DR
i,t
+ A
it
EPS
i,t =
earnings per share for firm i year t. P
i,t =
opening stock market price for firm i year t. R
i,t
= stock market return for firm i year t. DRi,t
=dummy variable, with 1 if Ri,t 0 bad news and 0 if Ri,t 0 good news.
20 If K
1
coefficient has a positive value and significantly differs from zero, then there is earnings conservatism in that company.
2. Ball and Shivakumar’s 2005 asymmetric cash flow to accruals
measure
Ball and Shivakumar 2005 developed this measure in order to estimate the degrees of accounting conservatism in private
companies. Ball and Shivakumar measure is based on the following regression:
ACC
t =
+
1
DCFOt+
2
CFO
t
+
3
DCFO
t
x CFO
t
+ A
t
ACC
t =
accruals measured as L inventory + L debtors + L other
current assets - L creditors - L other current liabilities – depreciation.
CFO
t =
cash flow for period t. DCFO
t =
dummy variable that is set to 0 if CFO
t
0, and set to 1 if CFO
t
0.
3. Market to Book or Book to Market ratio
Beaver and Ryan 2000 found idea underlying the use of market to book or book to market as a measure of accounting conservatism is
that, ceteris paribus, a conservative accounting system tends to depress the net book values of a firm relative to the firm’s a true
economic value. Therefore, a higher market to book and a lower book to market implies a higher degree of accounting conservatism
and vice versa.
21
BTM
i,t
